Does property-type diversification in REITs provide superior risk-adjusted returns if compared to specialized REITs? Evidence from the U.S. during different market conditions

Abstract

OBJECTIVES OF THE STUDY:

The aim of this study is to analyze the performance differences between different types of real estate investment trusts (REITs). In particular, I examine property-type diversification i.e. whether the stock market performance of diversified REITs differs significantly from specialized REITs. Additionally, I investigate whether performance differences are related to certain market conditions. Compared to the past studies, this study uses longer time span, latest data available, wider set of REITs, different methods for portfolio construction and more comprehensive calculations for performance measures. Also the implications of financial crisis are included.

DATA AND ANALYSIS:

The data set consists of 224 equity REITs: 176 classified as specialized and 48 as diversified. The time period for this study is from 2002 to 2015 including three sub-periods that present different market conditions. The study utilizes several performance ranking methods to investigate the performance differences between specialized and diversified portfolios. Sharpe ratio, Treynor Index, and Jensen's Alpha are computed based on total return data retrieved from Bloomberg. The statistical significance of performance differences is then studied with two-sample t-test, Wilcoxon rank-sum test, and Wilcoxon signed-rank test.

FINDINGS OF THE STUDY:

The results provide strong evidence that the diversified REITs outperform the specialized counterparts based on the superior risk-adjusted returns. The study also shows that the financial crisis of 2007-2009 strongly affects REIT returns. However, the assumed outperformance of specialized REITs during the crisis period cannot be identified. The superiority of the diversified portfolio can be partly explained by larger market capitalization (size), lower debt level, lower total operating expenses, and higher dividend yields.